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Cash Squeeze Inverts India's Corporate Bond Yield Curve

(Bloomberg) -- The Reserve Bank of India’s tight leash on liquidity is having an undesired effect on short-term borrowing costs for the nation’s companies, making it more expensive to sell one-year commercial paper than longer-tenor notes.

The cost of issuing 12-month commercial paper has risen to 7.84 percent, or 19 basis points more than average yields on notes maturing in three years, according to data compiled by Bloomberg. The gap had widened to as much as 20 basis points on Jan. 19, the most since February last year.

Excess cash with banks averaged 397 billion rupees ($6.2 billion) last week, compared to a peak of more than 5 trillion rupees in March, according to Bloomberg Intelligence India Banking Liquidity Index. India’s central bank is drawing liquidity out of the system as it seeks to keep inflation in check.

“Cash shortage is pushing up money market rates and inverting the yield curve” said Killol Pandya, head of fixed income at Essel Finance AMC Ltd. “I expect inversion to persist at least till March.”

“Every year during this time, mutual funds tend to float a lot of fixed-maturity plans that have a tenor of around three years,” he said. ”This results in buying interest in three year corporate debt, and pushes yields down, and further inverts the curve.”